Jan. 20 (Bloomberg) -- As Eastman Kodak Co. investors bet
the 131-year-old photographic pioneer was headed for bankruptcy,
the company decided Chapter 11 was the simplest way to become
the leaner digital printing specialist it aspires to be.

Bankruptcy allows sales of the photography divisions and
patents Chief Executive Officer Antonio Perez wants to jettison
to pay off legacy employee benefits and creditors, as he focuses
Kodak on faster, flexible commercial and consumer digital
printers and the company’s superior ink. Its trove of 11,000
patents could fund expansion by allowing the company to sue for
more licensing fees -- a move it has pursued more aggressively
in recent weeks.

Efforts to turn Kodak into a company that makes
sophisticated printers for the publishing, packaging, and
advertising businesses have burned cash. Raising funds from
intellectual property stalled amid delays in a royalty battle
with Apple Inc. and Research In Motion Ltd. Would-be asset
buyers shunned deals because of concern that sales made before a
Chapter 11 filing would be scrutinized in court for signs that
Kodak was fraudulently transferring assets cheaply. Now that the
filing has been made, that worry is gone.

“This is a melting ice cube of a business,” Amer Tiwana,
an analyst at CRT Capital Group LLC in Stamford, Connecticut,
said before the filing. “When you’re staring at a situation
like that, it’s typically better to go ahead and deal with it
rather than close your eyes and hope that the situation will
somehow miraculously improve.”

Easier to Sell

Bankruptcy makes it easier for Kodak to sell assets to pay
for layoffs, U.K. and U.S. employee pensions and health-care
benefits, and providing capital needed to install a big enough
base of digital printers to eventually be profitable.

The plan is to place printers with high volume users today
-- sometimes at a loss -- and profit from ink and service sales
tomorrow. The strategy to date has cost more money than it has
made.

Perez, Hewlett-Packard Co.’s former inkjet chief, believes
Kodak’s new commercial printers will displace older systems by
producing pages faster and cheaper on different materials with
digital flexibility. Kodak’s inks are made of longer lasting
pigments, unlike the watery dye used in most devices, allowing
quicker drying and smaller machines.

“We will now be well-positioned to complete our
transformation,” Perez said in a video. “Competing in large
markets, where we have fundamental technology advantages, such
as in digital printing, in packaging, in functional printing, in
materials.”

Inkjet Market

Perez plans to increase Kodak’s share of the consumer
inkjet printer market, which he has valued at $45 billion, by
designing cheaper replacement cartridges. He wants to dominate
commercial printing of magazines, books, newspapers and
advertising with high volume inkjet machines that are faster and
digitally flexible, to deliver smaller and more customized
batches cheaper than old-tech presses and plates as the world
moves toward on-demand publishing.

To be sure, Perez’s critics said the printing market itself
may shrink as the world embraces mobile devices such as tablets
and smart phones, eschewing traditional hard-copy publications
and paperwork.

“You’re betting on the wrong horse,” Tiwana said, noting
that most major paper producers have already gone through
bankruptcy, and that consumer printers, like digital cameras,
are becoming a commodity. “The amount of pain that printers and
printing companies are going to take over the next five years is
immense.”

Founder Largesse

Predictions computers would end the use of printed pages
have proved premature in the past, said Mark Zupan, Dean of the
Simon School at the University of Rochester. The university is
the biggest beneficiary of company founder George Eastman’s
largesse -- he bequeathed most of his fortune to the
institution. Still, Zupan acknowledged printing profitability
has eroded.

“The downside of the strategy is that printing is a very
competitive field,” Zupan said. “It’s going to be hard to
replicate what traditionally the film sector was able to provide
Kodak. Ultimately they’ll emerge a leaner company, either
independent or part of another company.”

Kodak’s answer is to revolutionize product packaging, an
area “immune to digital substitution,” Perez said in his
chairman’s letter in the 2010 annual report. The company is
promoting its Flexcel technology, which can print quickly on
diverse materials.

“Right now the printing business is too small to have an
impact,” Dave Novosel, an analyst at bond researcher Gimme
Credit LLC in Chicago, said before the filing. “The chances of
success with the current portfolio’s pretty slim, unless there’s
enough cash to get them through the next year, year and a half
and maybe these products catch on.”

Asset Sales

To raise cash, the company could sell other units including
Kodak Gallery, its online photo sharing unit that allows users
to store, share and print digital pictures on scrapbooks and
mugs; Kodak Picture Kiosk, where customers print their own
photographs in drugstores and other retailers; and its real
estate, including parts of its Rochester, New York,
headquarters. Kodak could license its brand to another camera-maker, said Mark Kaufman, an analyst at Rafferty Capital
Markets, earlier this month. Kaufman dropped coverage of Kodak
Jan. 11.

The company last year said it was preserving tax credits
from accumulated losses in anticipation of windfalls from asset
sales. So far only small deals have been announced, including a
gelatin factory in Pennsylvania and laboratory land in Colorado.

Factories Closed

As digital dissolved its film business, Kodak shed 47,000
employees since 2003 and closed 13 factories that produced film,
paper and chemicals, along with 130 photo laboratories. The
restructuring has already cost $3.4 billion, because it was done
“in a socially responsible” way, said spokesman Christopher
Veronda.

Kodak had counted on a victory in a patent-infringement
case against Apple and Research In Motion at the U.S.
International Trade Commission to help bring in as much as $1
billion in new revenue. Instead, the case had unexpected delays
and a final decision isn’t expected until September.

The company, which contends it invented many of the basic
aspects of digital imaging and deserves to be compensated, began
shopping more than 1,100 digital imaging patents for sale in
July. It’s also begun an aggressive patent-litigation strategy,
suing Apple, HTC Corp., Fujifilm Holdings Corp. and Samsung
Electronics Co. in the past week.

Apple Request

Apple asked the bankruptcy court to attach “clarifying
language” to any order approving financing for Kodak. Apple said
in a filing yesterday the order should indicate that no security
interests or liens will attach to patents that Apple owns and
has asserted claims on until the court resolves the ownership
dispute between it and Kodak.

Kodak has collected more than $3 billion in digital imaging
patent royalties since 2004, including a $550 million deal with
Samsung over technology used in mobile phones. The suit against
Samsung, filed the day before the bankruptcy filing, is over
tablet computers.

The securities market had decided weeks before last night’s
filing that Kodak would probably seek bankruptcy protection.
Bondholders are likely to recover about 28 cents on the dollar
on their investments, debt-market trading shows.

Moody’s Investors Service on Jan. 5 cut ratings on about $1
billion of Kodak debt with a negative outlook, and cited “a
heightened probability of a bankruptcy over the near-term” as
liquidity deteriorates.

Swaps

Credit-default swaps on Kodak that pay out after a default
or bankruptcy signal a recovery expectation of 25.5 cents on the
dollar for its senior unsecured bonds, according to data
provider CMA.

Five-year contracts tied to Kodak debt were quoted at 69.6
percent upfront, from 69 percent on Jan. 9 and 33 on Sept. 1,
according to CMA, which is owned by CME Group Inc. and compiles
prices quoted by dealers in the privately negotiated market.

That means investors now pay $6.96 million initially and
$500,000 annually to protect $10 million of Kodak’s obligations.
The swaps, which pay the buyer of the contracts face value,
minus the recovery value of the bonds that are set by dealers
and investors in an auction of the securities, are up from 12
percent upfront on Jan. 10, 2011, with a recovery of 34 cents on
the dollar. Recovery fell as low as 18 cents in October.

The company’s $250 million in 7.25 percent senior unsecured
notes due November 2013 fell to 27 cents on the dollar as of
7:54 a.m., according to Trace, the bond-price reporting system
of the Financial Industry Regulatory Authority. They traded at
29.5 cents as of 3:13 p.m. As recently as Jan. 9, they fetched
30 cents, and 63 cents on Sept. 27, compared with par on March
10.

Patents

Kodak’s patents -- including the digital imaging technology
it pioneered that ultimately destroyed its iconic photography
business -- may prove its most lucrative asset, said analysts
including Gimme Credit’s Novosel.

“Filing could actually free them up to sell the patents to
hopefully repay debtholders,” Bonnie Baha, the head of the
global developed credit group at DoubleLine Capital LP in Los
Angeles, which oversees $23 billion, said before the bankruptcy.

For Kodak’s hometown of Rochester, about 340 miles drive
from New York City, the legacy includes the university that has
educated thousands including business innovators, and grown to
become the state’s seventh largest employer. The name is
everywhere: Kodak Hall at Eastman Theatre, the Eastman School of
Music, and the Eastman Institute for Oral Health.

“Too much success can be your worst enemy” is today’s
lesson for all companies and entrepreneurs, said university dean
Zupan. “If you’re not willing to cannibalize yourself, others
will do it for you.”